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On Thursday, November 8, 2007, the IRS and Treasury issued proposed additional permitted modifications to commercial mortgage loans held by a “real estate mortgage investment conduit” (“REMIC”). The proposed REMIC rules respond to comments submitted by the Mortgage Bankers Association and Wachovia Bank, N.A. following the release of Notice 2007-17 (“Notice”), wherein the IRS and Treasury asked for industry assistance in determining the need to amend the REMIC rules to permit certain commonly requested modifications to commercial mortgage loans.

In May of 2007, IRS and Treasury officials met with representatives of Wachovia Bank, N.A., Alston & Bird LLP, the Mortgage Bankers Association and other interested parties to further the dialogue between the industry and the government on the issues and concerns faced by both sides in revising the current REMIC rules. Although still in proposed form, the rapid release of new REMIC rules are the first signs of success for the new IRS pilot program designed to increase public participation in the early stages of rule development with the goal of speeding its ultimate issuance. More importantly, the new rules, when in effect, will provide more flexibility to servicers of loans held in REMICs (“Servicers”) to accommodate the business needs of borrowers while preserving the value of a REMIC’s pool of investments.

Permitted Commercial Loan Modifications under the New REMIC Rules

When in effect, the new REMIC rules will permit Servicers to modify the terms of a commercial mortgage loan held in a REMIC to:

Permit the release, substitution, addition or other alteration of the collateral • for, or a guarantee (other form of credit enhancement) on, a recourse or nonrecourse obligation, but only to the extent that the obligation, tested on the date of such modification, would be treated as “principally secured by an interest in real property.”

Change the loan from recourse (or substantially all recourse) to nonrecourse (or substantially all nonrecourse), so long as the loan continues to be “principally secured by an interest in real property.”

–– Note, the actual text of this proposed rule, as written, only allows a change in a loan’s status from recourse to nonrecourse and does not expressly permit a change from nonrecourse to recourse. However, the IRS explanation of the proposed rules explicitly states that, “[A] commercial mortgage loan that is modified from nonrecourse to recourse and continues to be principally secured by an interest in real property will continue to be a qualified mortgage and will not be subject to the prohibited transaction tax under section 860F(a)(2).” We expect final regulations will resolve this inconsistency.

Central to the proposed REMIC rules is the concept of a loan that is “principally secured by an interest in real property.” This concept is not new in the REMIC rules, although the use of this concept in the modifications discussed above is new. For purposes of determining whether a loan subject to the above modifications will continue to be “principally secured by an interest in real property,” the fair market value of the collateral for the loan must be at least 80 percent of the amount of the loan. Fair market value should be determined as of the date of the modification, by an appraisal performed by an independent appraiser.

As stated previously, the proposed REMIC rules respond to some, but not all, of the comments received by the IRS and Treasury in response to the Notice. In particular, the proposed REMIC rules do not contain the industry’s request for permission to modify the terms of a loan to add a right to defease, nor do they permit a modification of the defeasance terms of a loan to allow a defeasance at any time following the expiration of the REMIC’s two-year defeasance prohibition period.

Effective Date of New REMIC Rules

Prior to issuing the proposed regulations as final, the IRS and Treasury will review comments from the public on the proposed regulations. A public hearing will be held to address concerns and comments if one is requested. The final regulations may be issued in a different form than the proposals described above based on comments provided by the public to the IRS and Treasury. The new REMIC rules will apply once they are published as final regulations.